It is not uncommon to hear about people who are active, sporty, even professional sports players and athletes, to be suddenly struck down in their prime with health issues that creeped up on them without realizing it.
Likewise, in investing, there are companies that may appear to be doing well – making a lot of money, highly profitable and efficient….
but bubbling underneath is a plethora of “ailments” that are not visible to the untrained eye until it is too late.
One of the more common ones is bad financial health.
In the previous two articles, we have identified the best growth stocks and ways to find them - fast growth, profitable and efficient
So, in this one, we will peer into the microscope as we dissect these businesses into even smaller parts to observe them further; particularly the Current Ratio, Debt Ratio and Interest Coverage Ratio.
1. Current Ratio
Current Ratio = Current Assets / Current Liabilities
One of the many liquidity measures in investing, Current Ratio is the comparison between a company’s current assets and their current liabilities.
Using this ratio, we are able to forecast whether a company has enough to meet their short-term obligations should creditors come knocking.
To quote an example, if a company’s current ratio is 2, it simply means that they have 2 times the amount of current assets needed to their cover their current liabilities.
If necessary, they can liquidate all their assets to pay for all their current liabilities – twice.
A company with Current Ratio of 2 generally indicates good financial liquidity.
Apple and Sony used to be longtime rivals when it comes to mobile phones – that is, until Sony’s mobile phones lost their charm, and were slowly phased out from that segment.
Here, we look at both company’s Current Ratios, with Apple Inc’s standing at 1.5x, whereas Sony Corp has only 0.8x.
From this point, we can see that Sony Corp’s Current Ratio is less than 1, which means they may not have enough current assets to cover their current liabilities.
Bear in mind though, this doesn’t mean the company would go bankrupt.
We can also choose to look at this from a different angle and metric, which is the Debt to Equity Ratio.
2. Debt to Equity Ratio
Debt to Equity Ratio = Debt / Equity
(Debt = Short Term Borrowing + Long Term Borrowing)
This is a ratio that could help us understand a company’s financial structure and how their assets are funded; whether it’s from borrowings (borrowed money) or Shareholders Equity (money they actually own). The lesser the borrowing, the smaller the ratio.
As a rule of thumb, companies with less than 0.5 times Debt to Equity Ratio are deemed less risky.
However, as we can gather from the images above, Apple Inc has a rather sizeable Debt to Equity Ratio, which is 1.1x whereas Sony has only 0.4x. From this perspective, it would seem like Sony is the wiser choice among the two.
The idea of debt has always been under negative light, but companies sometimes need to take on them anyway, for various reasons.
And they of course, comes with interest.
Another way to decide whether a company is healthy is whether they can afford to pay those interest from borrowings, which brings us to the next ratio – Interest coverage ratio.
3. Interest Coverage Ratio
Interest Coverage Ratio = Earnings Before Interest and Tax / Interest Expense
This metric is meant to assess a company’s ability to pay the interest for their borrowings.
When it deteriorates, it can sometimes be considered a warning sign.
Here, we can see that both Apple Inc and Sony Corp have high Interest Coverage Ratios, which means they can easily pay up their borrowings’ interests based on the earnings they make.
As a rule of thumb, Interest Coverage Ratios that are lower than 3 are considered to be red flags for investors. However, in this case, both companies are way above that.
Interest coverage ratio hasn’t been a popular ratio and is constantly underrated by investors, due to its complexity and the time required for its calculation.
That’s why WealthPark has decided to cut to the chase and included this ratio in its interface for investors who wants to have a more accurate view of a company’s numbers at their fingertips.
Claim your FREE 7-day trial to check out the financial figures for the companies you have invested.
And there you have it, the perfect candidate of a fast-growing company – strong growth track record, high profitability, efficiency and at the pink of health. So, if you’re ever lucky enough to spot any of these companies after hours of calculation, it might be a good idea to put them in your watchlist!
An alternative is to just use WealthPark Screener, select Green Gorilla, and hit “Screen”!
Now, instead of calculating for a few hours before finding a company that may or may not be investable, you can have ALL THE INVESTABLE COMPANIES within seconds. (Well, around 10 seconds to be exact)
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Growth companies compound capital.
However, as they are growing and would need all they can get to grow the business, they do not usually issue dividends. So, shareholders do not get to enjoy passive income cash flow investing in these type of companies – not for the first few years anyway.
Fortunately, there exist mature companies who could already afford to issue consistent and good number of dividends.
So, now that we know where to find the best growth stocks, why not find some great dividend companies as well?
What are the criteria and metrics we should look out for in dividend companies ?
Stay tuned for our next article where we will share about dividend companies and enter your email below to receive our next article alert.
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author(s) involved in the writing of this piece do not have current vested interest of the company. Please consult a competent professional for expert financial, or other assistance or legal advice.